The current problem of mounting bad loans on the books of PSU banks first caught public attention in early 2012 when a spurt, especially in their restructured standard loans (uncollectible loans that have been given a fresh lease of life) happened. As of end-March 2012, ratio of gross NPA plus restructured standard loans (for this combination, a creative and somewhat obfuscating term — stressed assets — was coined later) rose to 8.8 per cent from 6.6 per cent a year earlier. The corresponding numbers for new private sector and foreign banks were much lower.
Restructuring of loans – an avalanche Three years later (end-March, 2015), the ratio of stressed assets of PSU banks to their total loans were at a record high of 13.5 per cent, rising further to about 15 per cent in June. For private sector banks and foreign banks the numbers were 4.4 per cent and 3.6 per cent respectively. The actual size of the impaired assets of PSU banks is now in excess of Rs. 7 lakh crore, taking into account the securities receipts (SR) received on sale of NPAs and bonds of power distribution companies.
Political economy of banking The conventional wisdom regarding the provenance of the record build up of impaired loans at PSU banks is the decline in the country’s growth rate in the aftermath of the Global Financial Crisis (2008-10) and the policy atrophy during the second UPA regime, causing significant damage to new projects in infrastructure, power generation and civil aviation sectors. This line of reasoning is not completely devoid of merit, but it does not explain why PSU banks should be bleeding profusely and private sector and foreign banks should remain largely unscathed.
The agricultural debt waiver scheme announced in budget 2008-09 is perhaps the fountainhead of current PSU banking malaise. RBI's apparent enthusiasm in implementing it swiftly was in sharp contrast to its discomfort with debt forgiveness two decades earlier and more recently in Andhra Pradesh. The inspiration for debt restructuring programs were likely derived from the loan waiver scheme and served as the lynchpin for the “extend and pretend” regime.
Indiscretion of few ‘spread into madness of the many’ RBI issued a set of comprehensive guidelines on restructuring of loans in August 2008, but there was no relaxation of asset classification norms. However, soon thereafter in April 2009, major relaxations in asset classification norms were announced, permitting restructured loans to be categorized as ‘standard’, with a very interesting rider though. Banks could take advantage of the relaxation provided the restructuring was done within 120 days from the date of approval under the CDR mechanism and within 90 days from the date of receipt of application in other cases.
The pressure of time did not mean that PSU banks were restructuring indiscriminately. Their revealed preference was more for large loans under CDR mechanism and less for loans to small scale industries. During the years following the asset classification relaxation in 2009, ‘supervisory forbearance’ was also on display, as RBI’s bank examiners made little effort to make independent assessment of extra provision and capital requirements of PSU banks in respect of their burgeoning restructured standard loans, as required under Basel II standards. Even a straightforward fact that during 2009 and in the following few years, while the ratio of gross NPA to gross loans remained more or less steady, the restructured standard loans were rising very fast -- apparently did not warrant any serious supervisory response. Mr. Tarapore, former deputy governor of RBI had once cautioned RBI staff about the pitfalls of what he termed as ‘kindhearted supervision’. His words seem prophetic today. It is only recently that the RBI under the leadership of Dr. Rajan has called a full stop to the charade of ‘extending and pretending’.
Cozy arrangements with little accountability Lack of accountability has been most manifest at the level of the boards of PSU banks. The PJ Nayak Committee report has brought out several interesting bits of anecdotal information about their dysfunctional role. But alongside reforms in this regard, the past boards should be held accountable for what appears to have been systematic gaming of rules on restructuring. A little-known fact about the boards of PSU banks is that the nominee directors of the central government and the RBI were perceived as primus inter pares vis-a-vis other directors. The trio comprising the executive chair, government and RBI nominee directors would take all important business and other decisions, including career progression of their senior management staff. Quite clearly, they cannot escape accountability for the big holes in the finances of PSU banks. The taxpayers of the country have a right to ask the authorities to proceed against those who were lax in discharging their fiduciary responsibilities.
Economic consequences of ‘extending and pretending’ But serious damage has already been done. Provisions held by PSU are now very low provisions even vis-à-vis their recognized impaired assets. The shortfall will widen sharply if the likely accretion to impaired assets in future is taken into account. As of end-March, 2015, their loan loss provision was only 2.0 per cent vis-à-vis aggregate stressed assets of 13.5 per cent. Assuming that for all PSU banks, their restructured standard loans have a probability of 30 per cent to slip to NPA by end-March 2016, and taking the adequate provision coverage in respect of NPA to be at least 70 per cent, the provisioning shortfall for PSU banks works out to 3.4 per cent. It is highly possible that a few PSU banks are technically insolvent now.
Suggestions to deal with the impaired assets problem We have five specific suggestions to deal with this problem.
First, the government and RBI must recognize the scale of the problem.
The capitalization of PSU banks is grossly inadequate. Further, high impaired assets of PSU banks have already begun impeding credit flow to the economy thereby hindering growth.
Second, following the lead provided by SBI in this regard in 2014-15, PSU banks should be ready to sell their NPAs to asset reconstruction companies for cash at deep discount, if necessary.
RBI should provide flexibility to recognise the loss on sale of NPA over a five-year period in place of the extant two years. Banks are not only too big to fail but also too slow to change unless goaded with incentives. RBI's moral suasion alone will not work.
Third, disclosure of full and comprehensive information on the financial health of banks does not happen in India. It will be a good idea for RBI to conduct annual ‘stress testing’ of banks, following the methodology in the EU and US, and share the conclusions publicly.
Fourth, government must be prepared to lower its stake in PSU banks. The ‘Indradhanush’ reforms are just a good beginning. For achieving something real and durable, the government, the political class and the opinion-makers will have to jettison the long-held ideological belief that reduction of government’s equity stake below 50 per cent will be an act of sedition and sacrilege.
Fifth, all stakeholders must realize that commercial banking is undergoing a major transformation right now, driven largely by technology.
New innovations such as 'Blockchain' have the potential for disrupting banking business. Unless PSU banks invest in cutting edge technology and HR they will become irrelevant in 5-10 years.
Mr. Himadri Bhattacharaya is Senior Advisor, Riskontroller Global, U.S. and
Mr. Sivaprakasam Sivakumar, is Managing Director, Argonaut Global Capital LLC, U.S.